Forward-looking measures to keep rates steady
Near the end of 2017, the People’s Bank of China (PBoC) announced a provisional arrangement on reserve requirements. Any nation-wide bank that needs cash around the Chinese New Year can enjoy a 30-day two percentage point cut in their reserve requirement ratio, which is now 17% on deposits. This is designed to avoid cash hoarding behaviour by banks before the Chinese New Year. This year’s Chinese New Year holiday period falls between 15 to 21 February. This special measure is equivalent to a 30-day liquidity injection of around one to two trillion Chinese yuan into the banking sector. Through the interbank market, this holiday liquidity injection should ease tension for the broader financial sector, including nonbank financial institutions. Consequently, we do not expect any spikes in short-term interest rates in the money market around the Chinese New Year. This practice, if it works for the Chinese New Year, could be copied for other long holidays. We would like to highlight that this forward-thinking policy indicates that the central bank will be remarkably careful this year not to let interbank interest rates rise too speedily, although the market will have to get used to this pattern around holidays. This demonstrates the central bank is taking the government’s plan to 'avoid systemic risks' seriously.
We expect three hikes in repos this year
These measures do not mean interest rates will remain unchanged in 2018. To facilitate financial deleveraging we forecast the central bank will hike three times, each by five basis points on 7D repos to stabilise interest rate spreads between the yuan and the dollar. It is less likely that each hike would be 10bp as the central bank would worry that the money market could overreact, leading to spikes in rates.
It's not surprising that the central bank is so cautious given that financial deleveraging reforms are on the way, meaning liquidity will be tighter in 2018 compared to 2017. Financial regulators, including the PBOC and the banking regulator (CBRC), have set out new rules and issued policy consultation papers to encourage banks and financial institutions to conduct business more prudently. These include guiding principles of asset management business conducted by financial institutions and insurance companies, as well as regulating business between trust companies and banks to shrink off-balance sheet items. Regulators have separately given banks a year to build interest rate risk management models. Risks in the financial sector should diminish when more financial regulations are in place. But markets may worry that some marginal financial institutions could be prone to higher credit costs and liquidity risks.
Regulators want to see net capital inflows
Another 'avoid systemic risks' policy is to get net capital inflows into the economy. In essence, capital outflows mean drainage of liquidity from the domestic market to overseas markets. Apart from advising private corporates to invest sensibly overseas, the central bank has set personal overseas ATM withdrawal limits at 100,000 yuan per year. There was no such limit before, though the cap of US$50,000 personal overseas spending has been left unchanged. We believe that the regulator is closing these loopholes to stem capital outflows. Another way to attract capital inflows is to keep the yuan appreciating. But over-appreciation would be appealing to speculative money, which the regulators would not welcome. So we forecast a slower yuan appreciation rate of 3.0% in 2018 compared to 6.6%. In short, we believe that liquidity risks or financial counterparty risks are not rising in China. While financial deleveraging reform is imperative in 2018, regulators are aware that they need to take cautious measures to avoid systemic risks. This also explains our forecasts of three 5bp rate hikes to stabilise interest rate spreads between the yuan and the dollar. On top of this, to continue to attract net capital inflows, we forecast USDCNY and USDCNH will appreciate 3% from 6.5 in 2017 to 6.3 in 2018.
This article comes from our Monthly Economic Update. Download the full report here.